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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE YEAR ENDED JUNE 30, 2002
COMMISSION FILE NO.000-24969
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mPHASE TECHNOLOGIES, INC.
(Name of issuer in its charter)
NEW JERSEY 22-2287503
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
587 CONNECTICUT AVE., NORWALK, CT 06854-1711
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (203) 838-2741
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of Class)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the preceding 12 months (or for shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if the disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to the
Form 10-K.
As of August 26, 2002, there were 60,807,508 shares of common stock, no par
value, stated value $.01, outstanding and the aggregate market price of shares
held by non-affiliates was approximately $9,836,701 (Based upon a closing common
stock price of $.28 on August 26, 2002) (solely for the purpose of calculating
the preceding amount, all directors and officers of the registrant are deemed to
be affiliates.)
mPHASE TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 30, 2002
TABLE OF CONTENTS
PAGE
PART I
ITEM 1. Business 1
ITEM 2. Properties 23
ITEM 3. Legal Proceedings 23
ITEM 4. Submission of Matters to a Vote of Security Holders 24
PART II
ITEM 5. Market for Registrant's Common Equity and
Related Stockholder Matters 24
ITEM 6. Selected Consolidated Financial Data 25
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
ITEM 8. Financial Statements and Supplementary Data 37
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 37
PART III
ITEM 10. Directors, Executive Officers and Key Employees
of the Registrant 38
ITEM 11. Executive Compensation 40
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management 44
ITEM 13. Certain Relationships and Related Transactions 46
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 48
Report of Independent Public Accountants F1
Report of Certified Public Accountants F3
Financial Statements F4-F10
Notes to Financial Statements F11-F32
ITEM 15. Certifications 53
PART I
FORWARD-LOOKING STATEMENTS
This report contains "forward-looking statements." In some cases, you can
identify forward-looking statements by terms such as "may," "intend," "might,"
"will," "should," "could," "would," "expect," "believe," "estimate," "predict,"
"potential," or the negative of these terms and similar expressions intended to
identify forward-looking statements. These statements reflect the Company's
current views with respect to future events and are based on assumptions and
subject to risks and uncertainties. The Company discusses many of these risks
and uncertainties in greater detail in Part I, Item 1 of this 10-K under the
heading "Risk Factors." These risks and uncertainties may cause the Company's
actual results, performance, or achievements to be materially different from any
future results, performance, or achievements expressed or implied by the
forward-looking statements. You should not place undue reliance on these
forward-looking statements. Also, these forward-looking statements represent the
Company's estimates and assumptions as of the date of this report. The Company
is under no duty to update any of the forward-looking statements after the date
of this report to conform such statements to actual results or to changes in our
expectations.
The following discussion should be read in conjunction with mPhase Technologies'
financial statements and related notes included elsewhere in this report.
ITEM 1. BUSINESS
GENERAL DESCRIPTION OF BUSINESS
mPhase Technologies, Inc. ("mPhase" or the "Company") is a development stage
technology company headquartered in Norwalk, Connecticut. The Company is a
developer of broadband communications equipment and provider of digital video
content. The Company's flagship product, the Traverser(TM), enables telephone
companies and other telecommunications service providers to offer up to 384
channels of digital television, high-speed Internet and voice simultaneously
over their existing copper wire infrastructure. The Traverser(TM) utilizes
Digital Subscriber Line (DSL) technology to cost-effectively deliver a full
suite of communication services, e.g., voice, television and data services.
We believe the Traverser(TM) provides telephone companies with a cost-effective,
high quality and reliable means of converging communications services. To our
knowledge, the Traverser(TM) is the only platform that does not utilize Internet
Protocol (IP) transmission for the delivery of television services over
telephone wires to the end user. By utilizing a non-IP transport (NIP), we
believe certain quality of service issues that are often associated with
IP-based television delivery systems are negated. The patented bus architecture
of our system is such that all television channels are available to all users
all of the time as opposed to channel availability being based on ratios. Hence,
we feel that our solution is uniquely reliable. Furthermore, because we do not
utilize IP transport for the delivery of television, we do not require the use
of potentially costly equipment associated with IP-based television delivery
such as, ATM switches, servers or routers, as well as other ancillary equipment.
1
To facilitate sales of its flagship product, mPhase has established a subsidiary
company, mPhaseTelevision.net, Inc. ("mPhaseTV"). mPhaseTV has entered into
licensing agreements with content originators for upwards of 80 channels of
television content. mphaseTV can provide a single source of licensing agreements
for service providers interested in entering into the business of television
over telephone wires. By being able to offer this service to potential
customers, the Company believes it eliminates a potential barrier to purchase
and/or speeds the time to market for its customers.
Additionally, mPhase has developed a line of DSL component products. These
products include microfilters and splitters, and line extenders. Each of these
products can be used as components of the Traverser(TM) System, and can also be
sold as stand-alone products. The Company recently announced the release of its
"intelligent" line of central office POTS Splitters which the Company believes
significantly lowers the cost of deploying DSL services by reducing the
operational costs associated with loop qualification. The Company recently
entered into an exclusive worldwide distribution agreement with Corning
Cable Systems. Corning, through its global sales force, will be re-selling
mPhase's line of "intelligent" POTS splitter products to telecommunications
providers around the world.
Business Development, Organization, and Acquisition Activities
mPhase was incorporated in New Jersey in 1979 under the name Tecma Laboratory,
Inc. In 1987, the Company changed its name to Tecma Laboratories, Inc. As Tecma
Laboratories, Inc., the Company was primarily engaged in the research,
development and exploitation of products in the skin care field. On February 17,
1997, the Company acquired Lightpaths, Inc., a Delaware corporation, which was
engaged in the development of telecommunications products incorporating DSL
technology, and the Company changed its name to Lightpaths TP Technologies, Inc.
On January 29, 1997, the Company formed another wholly-owned subsidiary called
TLI Industries, Inc. The shares of TLI were spun off to its stockholders on
March 31,1997 after the Company transferred the assets and liabilities,
including primarily fixed assets, patents and shareholder loans related to the
prior business of Tecma Laboratories. As a consequence of these transactions,
the Company became the holding company of its wholly-owned subsidiary,
Lightpaths, Inc. on February 17, 1997.
On May 5, 1997, the Company completed a reverse merger with Lightpaths TP
Technologies, Inc. and thereafter changed its name to mPhase Technologies, Inc.
on June 2, 1997.
On June 25, 1998, mPhase acquired Microphase Telecommunications, Inc., a
Delaware corporation, by issuing 2,500,000 shares of its common stock.
Microphase Telecommunications' principal assets were patents and patent
applications utilized in the development of its proprietary Traverser(TM)
technology.
In March, 2000, mPhase entered into a joint venture with AlphaStar
International, Inc. to form an entity called mPhaseTelevision.Net, Inc. in which
the Company held a 50% interest. On May 1, 2000, the Company acquired an
additional 6.5% interest in mPhaseTelevision.Net, Inc. and made it one of its
consolidated subsidiaries.
2
On March 14, 2000, mPhase entered into an agreement with BMW Manufacturing
Corp., located in South Carolina. Under the agreement, the Company installed
version 1.0 of the Traverser(TM) for BMW's telephone transmission network. BMW
has agreed that, upon its notice and consent, mPhase will be able to demonstrate
to potential customers the functioning system at BMW's facilities. BMW has made
two (2) subsequent purchases increasing the size of the deployment to 48 unique
units.
Our flagship installation, Hart Telephone, has completed the build and
development of its digital headend during fourth quarter of 2001. The completion
of their digital headend marks the move from beta to commercial deployment of
the Traverser(TM) platform. Hart currently has approximately 100 customers
receiving about 90 channels of television services.
mPhase has initiated development of Version 2.0 of the Traverser(TM) with a
major, experienced research and development organization. Version 2.0 will be a
cost-reduced version of Version 1.0, offering similar functionality to version
1.0. We expect Version 2.0 to be commercially available for deployment in
Hartwell, as well as other locations, in early 2003. We believe such cost
reduced product will increase the competiveness of the Traverser(TM) against
other competing technologies in the global marketplace.
Our revenue, historically, has been derived from sales of component telephone
equipment parts, the majority of which has come from our sales of POTS Splitter
Shelves. In our fiscal year ended June 30, 2002, and through the third quarter
of our fiscal year 2002 ended March 31, 2002 we generated approximately $2.58
million and $1.95 million in revenue, respectively, from the commercial sale of
our component products. These component products, including filters and Central
Office POTS Splitter Shelves, are marketed to other DSL equipment vendors. We do
not believe that the sales of our Traverser(TM) will be materially impaired by
the sale of these component products to these potential competitors.
Products & Services
Traverser(TM) Digital Video and Data Delivery System
mPhase's principal and flagship product, the Traverser(TM) Digital Video and
Data Delivery System (DVDDS), is a patented end-to-end system enabling the
delivery of digital broadcast television, analog voice service and high-speed
data, as well as other ancillary services, over a single copper telephone wire.
Telcos using the mPhase Traverser(TM) System need to build a digital video
headend or programming and control center ("PCC") to receive television content.
This includes installing a satellite receiving dish, off-the-shelf video
equipment and mPhase's software to manage the video content at the PCC. Local
off-air channels are received, digitized and combined with the signals received
via satellite at the PCC. The PCC can be co-located with a single central office
or (CO) or remotely located and connected to each Central Office (CO) via dark
fiber, SONET ring or ATM networks.
3
The Traverser(TM) CO equipment, known as the mPhase Universal Access Shelf,
integrates video signals from the PCC with Internet and voice signals. The
output of the Universal Access Shelf consists of DSL "lines" capable of carrying
a single DVB-ASI, MPEG2 television channel, high-speed data and POTS (Plain Old
Telephone Service, to subscribers over existing telephone lines.
Upon reaching the home or business, the DSL line is fed into the mPhase INI(TM),
or digital set top box. The INI(TM) separates the three signals and routes them
to the television, PC and telephone.
Since its inception in June 1997, the Company's operating activities have
centered on developing, building and testing the Traverser(TM); establishing
relationships with third party developers, manufacturers and sales channel
partners; and commencing sales and marketing efforts. mPhase has not yet derived
any material revenue from the sale of the Traverser(TM).
The Company believes its product is unique and offers distinct competitive
advantages for a number of reasons. Foremost, the patented bus architecture
utilized by the Traverser(TM) allows a plurality of channels to be delivered to
a plurality of users all of the time ensuring unequivocal system reliability.
Additionally, because the Traverser(TM) does not utilize IP transport, it does
not require potentially costly equipment associated with IP-based television
delivery such as ATM switches, servers or routers, as well as other ancillary
equipment. Instead, the Traverser(TM) offers a cost-effective method to deliver
realtime broadcast television over copper phone wires. Additionally, the
Traverser(TM) does not require an upgrade of the existing infrastructure thereby
avoiding the capital expense required to support certain competing video over
DSL platforms.
The Traverser(TM) utilizes technology that mPhase licenses exclusively from
Georgia Tech Research Corporation ("GTRC") and DSL semiconductor chip technology
purchased from GlobeSpan Semiconductor, Inc. Georgia Tech Applied Research
Corporation ("GTARC") provides a significant portion of the engineering research
and design to develop the Traverser(TM). The Traverser(TM) also utilizes
component technology developed by Microphase Corporation, a privately-held
company with which mPhase shares common management.
4
Other Products
POTS Splitter Shelves
A Plain Old Telephone Service (POTS) Splitter Shelf is a low pass/high pass
filter that separates voice and data transmissions. POTS Splitter Shelves, are
necessary to permit simultaneous voice and data transmissions over the same
twisted copper wire pair. POTS Splitter Shelves and the individual cards that
populate the shelf, separate and re-combine traffic traveling along each copper
wire into the analog voice portion of a transmission and the digital data
portion, so that each signal can travel independent of the other. This product
allows for increased clarity of both voice and data information and decreased
"cross talk", or interference.
POTS Splitters are available in a domestic and an European Harmonized version to
service the international market as well as in a version that can support ADSL
over ISDN lines.
Intelligent POTS Splitter (iPOTS(TM)) and Universal Bypass
We believe the mPhase iPOTS(TM) offers a much needed solution for the DSL
industry; the iPOTS(TM) enables telcos to remotely and cost-effectively perform
loop management and maintenance including line testing, qualification and
troubleshooting. Prior to the introduction of the iPOTS(TM), loop management
could not be remotely performed through a conventional POTS Splitter without the
use of expensive cross connects or relay banks because of the mandatory DC
blocking capacitors in traditional POTS splitters, as required by the ITU, ANSI
and ETSI. The unique (patent pending) iPOTS(TM) circuit allows test heads to
perform both narrow and wideband testing of the local loop through the central
office POTS Splitter without having to physically disconnect the POTS Splitter,
thereby eliminating the need to dispatch personnel and a truckroll.
The iPOTS is a complete solution which includes a POTS Splitter as well as the
bypass or "intelligent" functionality and the UniversalBypass is a module
containing the intelligent functionality which can be used with any vendor's
POTS Splitter.
mPhase has recently entered into a distribution agreement with Corning Cable
Systems for its line of intelligent products. mPhase has granted Corning, one of
the world's leading suppliers of Central Office DSL components, the exclusive
worldwide distribution of its intelligent line. This agreement significantly
increases the potential exposure of this product line, as Corning has a global
salesforce and established relationships with the largest telephone companies in
the world.
mPhaseStretch
mPhase has recently introduced a new product known as the mPhaseStretch. This
product is a loop extender that enhances the performance of the Traverser(TM)
System by extending the transmission distance for the delivery of voice, video
and data up to 30,000 feet. The mPhaseStretch is a powered device that is placed
on the line at approximately 9,000 feet or before the signal begins to degrade.
We believe the addition of the Stretch gives mPhase the greatest serviceable
distance radius for the delivery of converged services. A universal version of
the Stretch(TM), or a version interoperable with other vendor's DSLAM equipment
is scheduled to be released later this year.
5
Microfilters
We have developed a complete line of microfilters, including a 2 and 4 pole
filter for use in single and multi-phone households, as well as a NID Splitter.
These products, similar to POTS Splitters, ensure clear and reliable service of
voice and high-speed data when these two services reside on the same line.
Target Market
Our primary business is to develop and market the Traverser(TM) to domestic and
international telephone companies and other communications service providers. We
position the Traverser(TM) to be the most cost-effective, reliable, scaleable
and easiest to operate TV-over-ADSL solution on the market.
mPhase markets its products in the U.S. to small, independent telephone
companies. We believe our product is ideal in markets where the population is
dispersed with relatively long loop lengths due to our advantage of having the
longest serviceable distance radius. Additionally, smaller telcos tend to be
more nimble and faster in their decision-making process. Also, many of these
telcos are located in areas where the competition for television services is
less intense than larger telcos located in urban markets.
mPhase also markets the Traverser(TM) System to international telephone
companies. Telephone companies around the world are experiencing negative
pressures on their calling revenues, encroaching competition from technologies
which were at one time complimentary (e.g., cable) and a need to increase their
per subscriber revenue. Outside of the United States, telcos are particularly
reliant on their copper infrastructure, as few countries have upgraded their
infrastructure to optics. Beyond that, the options for pay-tv services outside
the U.S. are, for the most part, limited. Consumers living abroad have less
access to digital television, leaving international telcos well-positioned to
capture a large percentage of the market. Hence, we believe the market
conditions that exist abroad are stronger for our product than those that exist
domestically.
While mPhase believes it will experience some success in the U.S., it
anticipates greater success in the international community. mPhase is focused
over the next several quarters on securing 1 to 2 large international telephone
companies as customers. To that end, it has several trials scheduled with major
international incumbent telcos, including one currently underway in Ankara,
Turkey.
mPhase is in the process of building reliable, reputable and productive
distributors and resellers and finalizing its certification process for
distributors and resellers. The Company then intends to aggressively pursue
relationships with distributors and resellers abroad that have
telecommunications experience and existing telephone company customers. We
believe that by capitalizing upon these kinds of relationships, mPhase will be
able to reach a greater international audience faster. An example of such a
relationship is mPhase's recently established agreement with Corning Cable
Systems for the worldwide distribution of its intelligent line of products.
6
mPhase Television.Net, Inc.
mPhaseTV provides contracts, licensing agreements, marketing and legal support
to service providers interested in deploying television over DSL. mPhaseTV has
established licensing agreements and partnerships with content originators thus
allowing service providers to offer its subscribers a full complement of
television programming. It is important to note that the role of mPhaseTV has
changed since its inception. Originally, mPhaseTV was to act as a content
aggregator, downlinking a complete lineup of channels, digitizing those channels
and uplinking them via satellite for further delivery to each telco site. The
benefit of mPhaseTV acting as a content aggregator was that service providers
would not have to build a full-scale headend that included encoders, and other
equipment. However, recent advances in technology have significantly reduced the
costs for a telephone company to build a full scale headend. Therefore the role
of mPhaseTV is now targeted to providing the licenses as opposed to offering an
aggregated content transport solution. Telephone companies purchasing content
through mPhaseTV are still required to build a full-scale digital headend.
We contributed the initial funding for the mPhaseTV, by lending it $1,000,000 at
8% per annum interest. The loan is repayable to us in common stock at the time
that mPhase Television qualifies for listing in the NASDAQ Small Cap Market. We
also contributed $20,000 in cash to the joint venture and granted options to
Alphastar to purchase 200,000 shares of our stock for $4.00 per share. The
agreement requires Alphastar to provide mPhaseTV the right to transmit
television broadcasts over Alphastar's digital satellite network. On May 1,
2000, we acquired an additional 6.5% interest in mPhaseTV for an additional
$1,500,000 in cash. We report mPhaseTV as a consolidated subsidiary.
As part of its cost reduction efforts, mPhase has renegotiated its joint venture
relationship with Alphastar International, Inc. that established mPhaseTV. Under
the original arrangement, mPhaseTV leased the rights to use Alphastar's earth
station satellite uplink and downlink facility in Oxford, CT. Pursuant to an
agreement dated as of June 18, 2002, mPhaseTV has terminated its lease of the
earth station and Alphstar and its affiliated entity have converted certain
accounts payable into shares of the Company's common stock.
mPhaseTV continues to serve as a strategic asset for selling the Traverser(TM)
by having secured the rights to transmit over DSL over 80 television channels
directly from the content providers eliminating the need for a U.S. telco
purchasing the Traverser(TM) from having to assemble such rights itself from
each of the content providers. mPhase currently owns a 56% controlling interest
in mPhaseTV.
7
Competitive Business Conditions
The telecommunications sector overall has experienced a significant global
downturn in spending over the past year. A number of once seemingly powerhouses
of the industry have faltered resulting in devasting effects across the
industry. The dramatic pull back in spending among service providers, coupled
with the malaise of the capital markets has halted the growth of the sector.
While the Company remains optimistic about the future of broadband, we don't
anticipate an upturn of events until service providers in general are able to
emerge from their current financial challenges.
In addition to the shifting economic climate, the telecommunications equipment
market is also characterized by swift technological change. Currently,
communications service providers have the option to offer several broadband
solutions in the last mile, including the existing ISDN or T-1 technologies,
fiber optic or hybrid coaxial cable and wireless and satellite delivery
methods. Communications service providers may use these other technologies
instead of DSL to offer their subscribers broadband access. There is currently a
bill in Congress that, if passed, could have positive effects on the
telecommunications industry overall and mPhase in particular. The Tauzin-Dingell
bill basically reduces the regulatory pressures on the larger incumbent
telephone companies in the U.S. It is speculated that this reduced pressure on
the RBOCs could result in greater spending among these companies and potentially
more funding available for the Company's products.
Based upon current telecommunications industry standards and deployment
methodologies, mPhase believes that DSL can compete favorably with these other
technologies, especially outside of the United States. In particular, telephone
companies and other copper-wire based service providers, which are interested in
maximizing the installed copper wire infrastructure from the standpoint of cost
effectiveness and ease of development, will favor DSL or other copper-based
broadband technologies.
mPhase's competitors that sell DSL systems like the Traverser(TM) or other
technologies, which incorporate broadband solutions over copper wire include:
ADC, Alcatel S.A., Copper Mountain, Advanced Fiber Communications, Innovia,
Ericsson, Fujistsu, Lucent Technologies, Marconi, NEC, Next Level
Communications, Nortel, Huawei Technologies Corporation Limited, Nokia, DVTel,
Inc., Turnstone, Paradyne Networks, Samsung, 2Wire, Siemens, TUT Systems,
Motorola, and Westell. In addition, we also compete with ImagicTV, Minerva and
Myrio Corporation, which provide infrastructure software products to deliver
multi-channel digital television over telephone networks by using Internet
Protocol.
Relative to other platforms that converge voice, video and data, we believe that
mPhase has the only non-Internet-Protocol platform that we are aware of on the
market. However, there are other IP-based platforms, such as the system offered
by Alcatel and Lucent and Innovia that enable the same suite of services to be
delivered using IP.
Next Level Communications, among others, offers a VDSL platform enabling
the delivery of voice, video and data over copper telephone wires. However,
because its platform is based on VDSL, it requires telcos to have a
fiber-to-the-neighborhood infrastructure. For some telcos the cost of this type
of infrastructure upgrade is prohibitive. Other equipment manufacturers offer
fiber-to-the-home solutions. While fiber in the home is an extremely robust
transmission medium, it is time and capital intensive to deploy.
8
Hybrid Fiber Coaxial Cable
Cable television providers are also competing in the space for converged
services using analog and digital cable connections that have been upgraded for
digital two-way services. In the United States, the majority of cable
connections have already been upgraded and can support the delivery of
television and high-speed Internet, and in may cases, cable telephony. In fact,
the imposing threat that cable companies present has created a catalyst among
telephone companies to expand their service offering to include advanced
services such as digital television.
Importantly, telephone companies have certain infrastructure advantages compared
to cable companies. A coaxial cable network is based on a shared platform, with
individual users sharing a common pipe or link between a central node back to
the Internet point-of-presence. Therefore, despite the large bandwidth capacity
of a coaxial cable infrastructure, the ultimate bandwidth for individual users
is negatively affected as more users access the Internet simultaneously. In
contrast, DSL is a point-to-point exclusive connection. No matter how many users
are accessing the Internet at the same time, subscribers will not experience
slowed data rates in the last mile due to congestion in the pipe.
Satellite
Satellite providers are at a distinct disadvantage with regard to competing in
the converged services arena. While satellite delivered television services in
the U.S. have experienced significant growth over the past several years, the
ability for satellite providers to offer reliable, consistent and cost-effective
high speed data is still in its infancy and too expensive to commercially
deploy. Furthermore, satellite providers are not typically equipped to offer
telephony services, unless they were to partner with a wireless telephony
provider. Beyond that, particularly outside of the US, the direct-to-home
satellite options are limited due to either low channel counts or unreliable
quality. Satellite signals are often affected by weather events such as severe
snow or rain, unlike DSL-delivered services which remain largely stable
regardless of the weather pattern.
Manufacturing
In late 1999, mPhase contracted with Flextronics, a major third party contract
manufacturer, to manufacture a prototype of its central office equipment and
Intelligent Network Interfaces(TM). The Company terminated its relationship with
Flextronics in March 2002.
Outsourcing
The Company practices an outsourcing model whereby it contracts with third party
vendors to perform certain functions rather than performing those functions
internally. For instance, mPhase outsources digital engineering development for
the Traverser(TM) System to GTARC. It also outsources analog engineering
development and certain administrative functions to Microphase Corporation. With
regard to manufacturing, mPhase is targeting leading contract manufacturing
companies with strategically located facilities in North America, Mexico and
Asia with which it can establish long-term relationships. By using contract
manufacturers, mPhase will attempt to avoid the substantial capital investments
required for internal production. Additionally, mPhase has just recently entered
an outsourcing arrangement for the sales and marketing of its intelligent line
of component products with Corning Cable Systems. Corning will be exclusively
reselling mPhase's intelligent component products worldwide.
9
Patents and Licenses
We have filed and intend to file United States patent and/or copyright
applications relating to some of our proposed products and technologies, either
with our collaborators, strategic partners or on our own. There can be no
assurance, however, that any of the patents obtained will be adequate to protect
our technologies or that we will have sufficient resources to enforce our
patents.
Because we may license our technology and products in foreign markets, we may
also seek foreign patent protection. With respect to foreign patents, the patent
laws of other countries may differ significantly from those of the United States
as to the patentability of our products or technology. In addition, it is
possible that competitors in both the United States and foreign countries, many
of which have substantially greater resources and have made substantial
investments in competing technologies, may have applied for, or may in the
future apply for and obtain, patents which will have an adverse impact on our
ability to make and sell our products. There can also be no assurance that
competitors will not infringe our patents or will not claim that we are
infringing on their patents. Defense and prosecution of patent suits, even if
successful, are both costly and time consuming. An adverse outcome in the
defense of a patent suit could subject us to significant liabilities to third
parties, require disputed rights to be licensed from third parties or require us
to cease our operations.
The intellectual property owned and licensed by the Company falls into two
general categories, analog and digital intellectual property.
mPhase owns the analog intellectual property which can be characterized as
filter technology. This intellectual property includes:
- - Low pass filter shelves and POTS Splitters, which combine the
Traverser(TM)DSL spectrum from the traditional voice service;
- - ADSL filters, which are filters that conform to the worldwide DSL
standard and are utilized in the transmission of data and voice service;
and
- - Bypass for telephone Splitter System, which enables an automated and
remote bypass of the POTS Splitter so full metallic testing can be
performed.
We have a pending patent application which was filed in June 1999 claiming
priority to three provisional patent applications for the analog portion of our
technology.
mPhase exclusively licenses our digital intellectual property from Georgia Tech
Research Corporation (GTRC). We also have an exclusive, worldwide license to
manufacture and market products using the technology developed by GTARC under
our contract with them. The exclusive license with GTRC is applicable for the
duration of their patent protecting the system design and other technology
related to the Traverser(TM). The digital intellectual property that we license
provides several unique aspects of the Traverser(TM). Among them is the
backplane design, which provides every subscriber the ability to view any
channel available. All subscribers in a given system could be watching the same
channel at the same time. The intellectual property licensed exclusively to
mPhase by GTRC includes the below mentioned patents.
10
A patent for the System and Method for the Delivery of Digital Video and Data
over a Communications Channel was issued on November 28, 2000 to the Georgia
Tech Research Corporation.
A patent was issued on March 27, 2001 to the Georgia Tech Research Corporation
for the System and Method for Maintaining Timing Synchronization in a Digital
Video Network. This patent covers the development of the Framer and the Framer
chip. The Framer is an Integrated Circuit which gives the Traverser(TM) the
capability of allocating both the downstream and upstream bandwidth into
virtually any application required. This feature allows the Traverser(TM) to
deliver both MPEG-2 digital video and Internet data simultaneously and also
allows for future applications of the Traverser(TM).
A patent was issued on November 27, 2001 to the Georgia Tech Research
Corporation for the Method and Apparatus for Combining a Plurality of 8B/10B
Encoded Data Streams addresses video data transport between digital headends and
the access network serving subscribers. A further patent is pending covering
other methods of video program transport.
Another patent was recently issued on August 13, 2002 covering what mPhase calls
the System Management Workstation (SMW). Specifically, this patent entitled,
"Computer System and Method for Providing Digital Video and Data Over a
Communication Channel" addresses the means by which the computer system and
method manages the already patented bus or broadcast backplane, for the delivery
of converged voice, video and data. The management system covered by this patent
performs functions such as monitoring the health of the Traverser(TM) system,
managing a database of user information, as well as linking multiple central
offices to a master system control station.
Georgia Tech also has patents pending that protect:
- - apparatus and methods of remote control of the Intelligent Network
Interface(TM); and,
- - systems and methods to provide subscribers means to playback previously
recorded video content.
We also rely on unpatented proprietary technology, and we can make no assurance
that others may not independently develop the same or similar technology to ours
or otherwise obtain access to our unpatented technology. If we are unable to
maintain the proprietary nature of the Traverser(TM) technology, our future
operations would likely be adversely affected.
11
Government Regulation
The Federal Communication Commission, or FCC, and various state public utility
and service commissions, regulate most of mPhase's potential domestic customers.
Changes to FCC regulatory policies may affect the accessibility of
communications services, and otherwise affect how telecommunications providers
conduct their business. These regulations may adversely affect the Company's
potential penetration into certain markets. In addition, its business and
results of operations may also be adversely affected by the imposition of
certain tariffs, duties and other import restrictions on components, which
mPhase obtains from non-domestic component suppliers. Changes in current or
future laws or regulations, in the U.S. or elsewhere, could materially adversely
affect the Company's business.
Research and Development
mPhase has designed the Traverser(TM) and its ancillary component parts in
conjunction with multiple research and development partners. GTARC conducts the
majority of our digital research and development for the Traverser(TM).
Microphase Corporation contributed the analog technology incorporated in the
design of the Traverser(TM), as well as providing ongoing development of analog
DSL components. mPhase has initiated negotiations for the development of Version
2.0 with a well-established research and development organization to compliment
GTARC. Version 2.0 will be a cost-reduced version of Version 1.0, offering
similar functionality at a significantly reduced cost. We anticipate that GTARC
will be involved in a reduced role with the development efforts of Version 2.0.
As of June 30, 2002, we had been billed approximately $13,424,300 for research
and development conducted by GTARC.
On March 26, 1998, we entered into a license agreement with GTRC which has the
patent on the Digital Video and Data Delivery System technology. GTRC has
granted us the exclusive license to use and re-sell this technology in the
Traverser(TM). We are required to pay GTRC royalties of 5% on the sales of the
Traverser(TM). The agreement expires automatically when the patents covering the
invention expire.
Employees
mPhase presently has approximately 12 full-time employees, two of whom are also
employed by Microphase Corporation. See the description in the section entitled
"Certain Relationships and Related Transactions."
Risk Factors
An investment in mPhase's common stock involves a high degree of risk. You
should carefully consider the following risks before making an investment
decision. You should also refer to the other information set forth in this
document, including the Company's financial statements and the related notes.
12
Risks Related to Financial Aspects of the Company's Business
mPhase expects to incur substantial net losses for the foreseeable future and
expects to need to raise substantial additional capital.
mPhase expects to generate operating losses and negative cash flow into the
foreseeable future because it must fund its increasing sales, marketing and
promotional activities, its equipment production efforts and its continued
research and development activities to maintain its technology and develop new
technology. The Company expects to fund these activities through additional
public or private offerings of its stock. mPhase had net losses, including
non-cash charges for stock based employee compensation, of approximately $24.0
and $11.3 million for the twelve-month periods ended June 30, 2001 and June 30,
2002, respectively. The Company has sold Splitters and Microfilters of
approximately $2.58 million for the period between June 30, 2001 and June 30,
2002. mPhase cannot be certain when and if it will achieve sufficient revenues
in relation to its expenses to become profitable. The Company believes that
increasing its revenues will depend in large part on its ability to:
- raise additional capital;
- finalize the commercial design of the Traverser(TM)and its
management software;
- decrease the overall cost of our system significantly;
- generate significant revenue from sales of the Traverser(TM);
- gain market acceptance for its products and increase its
market share based upon the timing, strength and success of
its sales efforts and its strategic and commercial alliances;
- develop effective marketing and other promotional activities
to penetrate its target customer base;
- develop strategic and commercial relationships that balance
its current and long-term ability to capitalize on its
technology; and
- generate and sustain substantial revenue growth while
maintaining reasonable expense levels.
Slower revenue growth than mPhase anticipates or operating expenses that exceed
its expectations would materially harm its business. If the Company achieves
profitability, it cannot be certain that it will be able to sustain or increase
that profitability in the future.
mPhase's limited operating history makes it difficult for you to evaluate its
business and prospects.
As of June 30, 2002, mPhase received no purchase orders for the Traverser(TM) or
programming content offered by its subsidiary mPhaseTelevision.Net. The
Company's revenue of approximately $10,524,100 for the fiscal year ended June
30, 2001 and $2,582,446 for the fiscal year ended June 30, 2002 was derived
largely from sales of its DSL component products. mPhase generated $20,000,
$5,540 and $97,700 from sales of trial versions of the Traverser(TM) product for
the fiscal year ended June 30, 2000, 2001 and 2002 respectively.
13
As a result, the Company has only a limited operating history and no sales of
its principal product upon which you may evaluate its business and prospects.
You should consider mPhase's prospects in light of the heightened risks and
unexpected expenses and difficulties frequently encountered by companies in an
early stage of development. These risks, expenses and difficulties, which are
described further in this section entitled "Risk Factors", particularly apply to
mPhase because the market for equipment that delivers voice, data and video
services is new and rapidly evolving. Due to the Company's limited operating
history, it will be difficult for you to evaluate whether it will successfully
address these risks.
mPhase's sales cycle is lengthy and variable so the timing of its revenues is
difficult to predict, and it may incur sales and marketing expenses with no
guarantee of future sales.
mPhase's potential customers view the purchase of the Traverser(TM) as a
significant and strategic decision. As a result, its customers, the foreign and
domestic telecommunications service providers, will typically undertake
significant evaluation and testing of its products before deployment. This
evaluation process frequently results in a lengthy sales cycle, typically
ranging from six months to more than a year. Furthermore, mPhase is targeting
international communications service providers, which operate under a number of
different telecommunications equipment compliance standards. These international
service providers will require that mPhase receive local standards approval
before it is able to enter into field trials or definitive sales agreements.
Furthermore, because the Company is selling a new product with limited real
environment exposure, tests and trials may not necessarily result in purchases
of the Traverser(TM).
Before a customer places an order, mPhase may incur substantial sales and
marketing expenses and expend significant management efforts. In addition,
because its customers are both domestic and foreign telecommunications service
providers, product purchases may frequently be subject to unexpected government
regulatory, administrative, processing and other delays on the part of its
customers. Moreover, purchase orders for mPhase's products may have lengthy
payable periods because of payment delay from its customers. As a result, sales
forecasted attributable from a potential customer may not be realized and this
could result in lower than expected revenues.
mPhase may not be able to obtain sufficient financing to fund its business and,
as a result, it may not be able to grow and compete effectively.
Investors in mPhase should be able and prepared to sustain an entire loss of
their investment. If unable to sustain such losses investors are advised to
thoroughly and carefully consider their investment in this Company.
mPhase expects to incur substantial expenses to develop and market its products.
It expects to generate losses into the foreseeable future so it does not expect
that the income from its operations will be sufficient to satisfy its cash
requirements. The Company may need additional capital if it needs to respond to
unforeseen technological or marketing hurdles, or if it desires to take
advantage of unanticipated opportunities. Therefore, mPhase will need to seek
additional financing from public or private sources. The Company's success in
raising enough additional financing to satisfy its capital requirements will
depend on a number of factors, including:
- - market conditions;
- - the success of its product development efforts;
- - the volatility of the price of the Company's common stock;
- - its operating performance; and
- - investor sentiment.
14
The status of these factors may make the timing, amount, terms and conditions of
additional financing unattractive for mPhase. In addition, to the extent that
the Company is able to obtain additional financing through the issuance of
equity securities, its stockholders may experience dilution. If the Company
obtains financing through loans or any other type of debt financing, it may
become subject to restrictions on its spending or ability to pay dividends.
Funds may not be available at the time or times needed on terms acceptable to
the Company, if at all. If adequate funds are not available, or are not
available on acceptable terms, mPhase may not be able to take advantage of
market opportunities, to develop products or to otherwise respond to competitive
pressures effectively.
mPhase's Operations May Become Strained Due to its Growth.
Upon successful testing and introduction of the Traverser(TM), mPhase will need
to expand its marketing and sales efforts, operations and production, as well as
provide customer support. The Company's management, personnel, systems,
procedures, controls and customer service may be inadequate to support such
expansion. The Company expects significant strains on its order and fulfillment
process, its quality control systems and customer support once the sales of the
Traverser(TM) commences. To manage expansion effectively, mPhase must implement
and improve its operational systems, procedures, controls and customer service
on a timely basis and increase its staff or obtain these services through third
party contractors. The Company will also require capital to attain this growth
and management. If the Company is unable to properly manage operations, controls
and customer support, or secure financing to implement this growth, its
operating results, reputation and customer relationships could be harmed.
Risks Related to mPhase's Products and Target Markets
A significant market for the Company's products may not develop if telephone
companies do not successfully deploy broadband services such as high-speed data
and video.
Many telephone companies have recently begun offering high-speed data services.
Most telephone companies have not offered multi-channel video services at all.
Unless telephone companies make the strategic decision to enter the market for
providing television services, a significant market for mPhase's products may
not develop. Sales of its products largely depend on the increased use and
widespread adoption of broadband services and the ability of its customers to
market and sell broadband services, including video services, to their
customers. Certain critical issues concerning use of broadband services are
unresolved and will likely affect their use. These issues include security,
reliability, speed and volume, cost, government regulation and the ability to
operate with existing and new equipment. Even if telephone companies decide to
deploy broadband services, this deployment may not be successful. Telephone
companies may delay deployments of broadband services. Factors that could cause
telephone companies not to deploy, to delay deployment of, or to fail to deploy
successfully the services for which mPhase's products are designed include the
following:
15
- industry consolidation;
- regulatory uncertainties and delays affecting telephone
companies;
- varying quality of telephone companies' network infrastructure
and cost of infrastructure;
- upgrades and maintenance;
- inexperience of telephone companies in providing broadband
services and the lack of sufficient technical expertise and
personnel to install products and implement services
effectively;
- uncertain subscriber demand for broadband services; and
- inability of telephone companies to predict return on their
investment in broadband capable infrastructure and equipment;
- decreased capital expenditures by telephone companies.
Unless mPhase's products are successfully deployed and marketed by telephone
companies, it will not be able to achieve its business objectives and increase
its revenues.
Government regulation of mPhase's customers and related uncertainty could cause
its target customers to delay the purchase of its products.
mPhase's target market consists of domestic and international telecommunications
service providers. Domestic communications service providers are regulated by
the Federal Communications Commission, or FCC. They also require that equipment
located at their facilities comply with FCC, NEBS, UL and ANSI standards.
International telecommunications service providers operate under a number of
various equipment compliance standards and are regulated by their respective
governments and agencies. These international service providers will require
that mPhase receive local government and regulatory approval before it is able
to enter into field trials or definitive sales agreements.
In the U.S., The Telecommunications Act of 1996 requires regional Bell operating
companies, to offer their competitors cost-based access to some elements of
their networks. These telephone companies may not wish to make expenditures for
infrastructure and equipment required to provide broadband services if they will
be forced to allow competitors access to this infrastructure and equipment. The
FCC recently announced that, except in limited circumstances, it will not
require incumbent carriers to offer their competitors access to the facilities
and equipment used to provide high-speed data services. Nevertheless, other
regulatory and judicial proceedings relating to telephone companies' obligations
to provide elements of their network to competitors are pending.
The uncertainties caused by both foreign and domestic regulatory proceedings may
cause telephone companies to delay purchasing decisions. The outcomes of any
regulatory proceedings may cause these telephone companies not to deploy
services for which mPhase's products are designed or to further delay
deployment. Additionally, telephone companies' deployment of broadband services
may be slowed down or stopped because of the need for telephone companies to
obtain permits from city, state, federal or foreign national authorities to
implement infrastructure for products such as mPhase's. Any delay in deployment
of products by the Company's customers could harm its sales.
16
mPhase's potential customers will not purchase its products if they do not have
the infrastructure necessary to use its products. The Traverser(TM) is based on
the use of copper telephone wire. The copper wire infrastructures installed and
maintained by telephone companies vary in quality and reliability. A significant
portion of the existing networks have been installed and repaired over many
years and may be out of date. The copper wiring used by telephone companies is
also unshielded, making data transmission susceptible to interference. In
addition, copper wiring has a basic transmission property that causes the signal
quality to degrade rapidly as the frequency increases or the distance traveled
by the signal increases. As a result of these limitations, the Traverser(TM) may
not be a viable solution for customers requiring service at performance levels
beyond the current limits of copper telephone wire and this could harm mPhase's
sales.
Successful implementation of the Traverser(TM) is highly dependent on the
telephone companies' commitment and ability to continue to maintain their
infrastructure so that it will operate at a consistently high performance level.
Copper wire infrastructure upgrades may be costly, and telephone companies may
not have the necessary financial resources. This is particularly true for the
smaller independent telephone companies and international telephone companies
who are an important part of mPhase's target market. If its potential customers
lack the adequate infrastructure, the Company may not be able to sell the
Traverser(TM) to them and generate the revenues it anticipates.
Additionally, in order to utilize mPhase's products to offer digital video
services, its potential customers may need to build a digital headend to receive
video broadcasts and install fiber optic cable from the headend to each central
office. The capital expenditures required to install a headend may exceed the
financial resources of its potential customers. There can be no assurance that
its potential customers will make the investment necessary to upgrade their
facilities in order to use mPhase products.
Some telecommunications service providers, such as Bell Canada, are currently
offering Direct Broadcast Services, commonly referred to as "DBS", a technology,
which provides multiple channel digital television through satellite
distribution to individual satellite dish receptors located at the home. Since
there are telecommunications service providers that sell or re-sell DBS
services, these companies already provide their subscribers with access to a
digital television service and do not require the Company's technology to
provide digital video services.
Risk Related to the Industry
Intense competition in the telecommunications equipment market could limit or
prevent mPhase's profitability.
The telecommunications equipment market is characterized by swift technological
change. Several available technologies such as fiber optic cable, co-axial cable
and hybrid co-axial cable, wireless transmission and satellite transmission
compete with DSL for market share. Communications service providers may also use
other technologies such as ISDN (Integrated Services Digital Network), or
IP-based or fiber-based DSL solutions to deploy high-speed services comparable
to those provided by the Company's Traverser(TM) products.
17
mPhase's competitors who sell DSL systems like the Traverser(TM) or other
technologies, which incorporate broadband solutions over copper wire include:
ADC, Alcatel S.A., Copper Mountain, Advanced Fiber Communications, Innovia,
Ericsson, Fujistsu, Lucent Technologies, Marconi, NEC, Next Level, Nortel,
Huawei Technologies Corporation Limited, Nokia, DVTel, Inc., Turnstone, Paradyne
Networks, Samsung, 2Wire, Siemens, TUT Systems, Motorola, and Westell. In
addition, we also compete with ImagicTV and Myrio Corporation, which provide
infrastructure software products to deliver multi-channel digital television
over telephone networks by using Internet Protocol.
If mPhase is unable to compete effectively in the telecommunications market or,
in particular, the market for DSL telecommunications equipment, the Company's
revenue and future profitability may be materially adversely affected. Most of
mPhase's current and potential competitors have significantly greater selling
and marketing experience, technical capability and manufacturing and financial
resources. mPhase's competitors may be able to predict future market trends more
accurately than the Company can and, as a result, develop new technologies that
compete with its products or even render its products obsolete. Although mPhase
believes that its products have certain technological advantages over its
competitors, realizing and maintaining such advantages will require a continued
high level of investment in research and development, marketing and customer
service and support. Additionally, new competitors with greater market presence
and financial resources may enter the Company's market, thereby further
intensifying competition.
Technologies that compete with mPhase's products include telecommunications-
related wireline technologies, cable-based technologies, fixed wireless
technologies and satellite technologies. If the Company's potential customers
choose these alternative technologies to deploy high-speed services, its
business, financial condition and results of operations could be harmed.
mPhase's technology may not be able to compete effectively against these
technologies on price, performance or reliability. While the Company believes a
market exists for its products, there can be no assurance that its products will
gain wide market acceptance or that it will be able to maintain any market share
through innovation. The development of mPhase' DSL products is a complex and
uncertain process requiring accurate anticipation of technological and market
trends. The Company may not be successful in its development or introduction of
new products.
mPhase's equipment is subject to regulation and certification.
The Federal Communications Commission requires that telephone equipment used in
central offices be certified in accordance with Parts 15 and 68 of its rules and
regulations. Part 15 specifies a maximum allowable amount of electromagnetic
radiation from an electronic device in a commercial or residential environment
at specific frequencies. Part 68 tests the equipments resistance to lightning
strikes. The Underwriters Laboratories (UL) 1950 Standard applies to our
customer premise equipment called the Intelligent Network Interface(TM).
National Equipment Bureau of Standards (NEBS) testing is also recommended for
U.S. telco equipment. It assures a telco that the equipment does not require
extensive installation and is reliable. The testing covers a large range of
requirements including criteria for personnel safety, protection of property,
and operational continuity. NEBS also covers physical requirements including:
Space Planning, Temperature, Humidity, Fire, Earthquake, Vibration,
Transportation, Acoustical, Air Quality and Illumination; and electrical
criteria including: Electrostatic Discharge (ESD), Electromagnetic Interference
(EMI), Lightning and AC Power Fault, Steady State Power Induction, Corrosion, DC
Potential Difference, Electrical Safety and Bonding and Grounding. In addition,
Underwriters Laboratories also requires certain safety standards be tested and
certified.
18
The Central Office Traverser(TM) equipment is currently undergoing NEBS testing,
that will include FCC Part 68 and FCC Part 15 certification. The Customer
Premises Traverser(TM) equipment is FCC Part 68 and FCC Part 15 certified and is
also UL listed. The Traverser(TM) has not completed all certification testing
and there can be no assurance that it will be fully certified. In the event that
the Traverser(TM) fails any portion of the certification testing, the product
may need to be redesigned, mPhase may incur significant increases in its
development expenses and the production of the Traverser(TM) will be delayed.
The Company's ability to sell the Traverser(TM) if it is not able to obtain
certification will be hindered and will have difficulty conducting its plan of
operations as currently contemplated.
mPhase's products may become obsolete.
mPhase's position in existing markets or potential markets could be eroded
rapidly by product advances. The life cycles of its products are difficult to
estimate. The Company's growth and future financial performance will depend in
part upon its ability to enhance existing products and develop and introduce new
products that keep pace with:
- the increasing use of the Internet;
- the growth in remote access by telecommuters;
- the increasingly diverse distribution methods for high quality
digital video; and
- other industry and technological trends.
mPhase expects that its continued and future product development efforts will
continue to require substantial investments. The Company may not have sufficient
resources to make the necessary investments. If it fails to cost-effectively
develop new products that quickly respond to new competition and customer
requirements, the demand for its products may fall and the Company could lose
revenues.
Other Risks Associated with mPhase's Business
mPhase depends on a third party to develop its products. The Company relies upon
GTARC, an affiliate of the Georgia Institute of Technology, for research
concerning the Company's digital technology and products. mPhase has entered
into a Research Agreement with GTARC, which includes a series of delivery orders
providing guidelines for the research and development of portions or components
of the Traverser(TM). GTARC developed working prototypes and the version 1.0
Traverser(TM). mPhase's business will be materially adversely affected if GTARC
does not perform its responsibilities under the agreement on an acceptable basis
or terminates the relationship and mPhase is unable to replace their development
services on a prompt basis, if at all.
19
mPhase's success depends on its ability to protect its intellectual property.
Georgia Tech Research Corporation has been awarded (i) patent #6,154,772 dated
November 28, 2000 entitled System and Method for the Delivery of Digital Video
and Data over a communications channel, (ii) patent #6,208,666 dated March 27,
2001 entitled System and Method for Maintaining Timing Synchronization in a
Digital Video Network, (iii) patent #6,323,789 issued November 27, 2001 entitled
Method & Apparatus for Combining Plurality of 8B/10B Encoded Data Streams, and
(iv) patemt #6,434,562 issued August 13, 2002 entitled Computer System and
Method for Providing Digital Video and Data Over a Communication Channel. Even
if patents are obtained, they may not adequately protect the Company's
technologies from third party infringement. The Company may seek foreign patent
protection, but foreign patent protection may not be granted. mPhase's failure
to protect its intellectual property could materially adversely affect it.
The telecommunications industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert patent, copyright,
trademark and other intellectual property rights to technologies that are
important to mPhase's business. Any claims asserting that the Traverser(TM) and
component parts infringe or may infringe proprietary rights of third parties, if
determined adversely to the Company, could have a material adverse effect on its
business, financial condition or results of operations. In the event of an
adverse result in any litigation with third parties that could arise in the
future, mPhase could be required:
- to pay substantial damages, including paying treble damages if
the Company is held to have willfully infringed;
- to halt the manufacture, use and sale of infringing products;
- to expend significant resources to develop non-infringing
technology; and/or
- to obtain licenses to the infringing technology.
Licenses may not be available from any third party that asserts intellectual
property claims against mPhase, on commercially reasonable terms, or at all. In
addition, litigation frequently involves substantial expenditures and can
require significant management attention, even if the Company ultimately
prevails. In addition, the Company indemnifies its customers for patent
infringement claims, and it may be required to obtain licenses on their behalf,
which could subject it to significant additional costs.
20
mPhase contracts for the manufacture of all of its products and have limited
in-house manufacturing capabilities. The Company relies primarily on other
companies to manufacture our products. The efficient operation of its business
will depend, in large part, on its ability to have these other companies
manufacture its products in a timely manner, cost-effectively and in sufficient
volumes while maintaining consistent quality. Any manufacturing disruption could
impair mPhase's ability to fulfill orders and could cause it to lose customers.
mPhase's products use components that may not be available due to excessive
market demand. Shortages of these components could increase significantly the
Company's costs and adversely impact its profitability. If the Company is not
able to obtain component parts for its equipment, then its sales will be
adversely impacted because it may not be able to deliver its equipment to
customers in a timely manner.
mPhase has common management with affiliates who supply it with components.
Necdet F. Ergul, the Chairman of the Board, Ronald A. Durando, the President and
Chief Executive Officer, and Gustave T. Dotoli, the Chief Operating Officer and
Vice President, respectively, are officers of Microphase Corporation. Necdet F.
Ergul, is a major shareholder of Microphase Corporation. Microphase provides
resources and technology related to the development of the Traverser(TM), and
other DSL products. Microphase may not be the most economical provider of this
technology and resources and conflicts of interest may arise due to the
relationship between mPhase and Microphase. In addition, the Company will pay to
Microphase a royalty comprised of 3% of any commercial product sales of any
DSL-related technologies.
Ronald A. Durando and Gustave T. Dotoli are also president and vice-president,
respectively, of PacketPort.com, Inc., a company that develops Internet Protocol
Telephony products and services. Packetport.com, Inc. is in the process of
launching a complete line of Packet Telephony products.
Janifast, Ltd., a Hong Kong company, is the manufacturer that produces
components for the prototype Traverser(TM) and may produce such components for
mPhase in the future. Necdet F. Ergul, Ronald A. Durando and Gustave T. Dotoli
are controlling shareholders of Janifast, Ltd. with an aggregate ownership
interest of greater than 75% of Janifast, Ltd. Mr. Durando is Chairman of the
Board of Directors of Janifast, Ltd. and Mr. Ergul is a Director of Janifast,
Ltd.
mPhase's success depends upon the services of its senior management and key
technical personnel, including its Chief Executive Officer, Ronald A. Durando,
its Chief Operating Officer, Gustave T. Dotoli, its Chief Technology Officer,
David Klimek and its Chief Financial Officer and General Counsel, Martin S.
Smiley. The loss of the services of any of these executive officers or any of
the Company's key management, sales or technical personnel could have a material
adverse effect on its business and prospects. In addition, the Company's success
is largely dependent upon its ability to hire highly qualified managerial, sales
and technical personnel. These individuals are in high demand and mPhase may not
be able to attract the caliber or quantity of staff that is needed.
21
The price of mPhase's common stock has been volatile and may fluctuate
substantially. The stock market has periodically experienced significant price
and volume fluctuations that have affected the market prices for the securities
of technology companies such as the Company. As a result, investors in its
common stock may experience a decrease in the value of their common stock
regardless of its operating performance or prospects.
Additionally, mPhase's stock price may be subject to substantial fluctuations in
response to a variety of factors, including:
- problems encountered when testing the Traverser(TM);
- fluctuations in quarterly operating results;
- changes in reports by financial analysts;
- announcements of strategic relationships, acquisitions or
capital commitments by the Company or its competitors;
- recent technological innovations;
- new products or services offered by the Company or its
competitors;
- changes in key personnel;
- changes in strategic relationships with third parties by the
Company or its competitors; and
- sales of common stock;
Many of these events or factors are beyond mPhase's control.
Anti-takeover provisions in mPhase's charter documents and New Jersey law could
prevent or delay a change in control of the Company that a stockholder may
consider favorable.
If a proposal by mPhase's directors is approved by its stockholders, certain
provisions of its certificate of incorporation and by-laws would make it more
difficult for a third party to acquire control of the Company, even if such
change in control would be beneficial to or favored by its shareholders. For
example, provisions of mPhase's certificate of incorporation include:
- prohibiting cumulative voting in the election of directors;
- restricting business combinations with interested
stockholders;
- issuance of preferred stock without stockholder approval;
- the existence of a rights plan, which would have the effect of
providing some holders of its common stock with a premium of
the market price of its stock;
- limiting the persons who may call special meetings of
stockholders; and
- establishing advance notice requirements for nominations for
election to the Board of Directors or for proposing matters
that can be acted on by stockholders at stockholder meetings.
22
As a New Jersey corporation, mPhase is also subject to the New Jersey
Shareholders Protection Act contained in Section 14A:10A-1. In general, Section
14A:10A-1 prohibits a publicly-held New Jersey corporation from engaging in a
"business combination" with an "interested shareholder" for a period of five
years following the date the person became an interested shareholder, unless,
among other things:
- the Board of Directors approved the transaction in which such
a shareholder became an interested shareholder prior to the
date the interested shareholder attained such status; and,
- the business combination is approved by the affirmative vote
of the holders of at least 66 2/3% of the corporation's voting
stock not beneficially owned by the interested shareholder at
a meeting called for such purpose.
A "business combination" generally includes a merger, sale of assets or stock,
or other transaction resulting in a financial benefit to the interested
shareholder. In general, an interested shareholder is a person who, together
with affiliates and associates, owns, or within five years prior to the
determination of interested shareholder status, did own, 10% or more of the
corporation's voting stock.
Future sales by holders of mPhase's common stock and warrants may cause the
market price of its stock to decline.
mPhase's stock price may decline as a result of sales of a large number of
shares in the market after the recent registration of 40,528,932 shares on an
amended S-1 registration statement. These factors could make it more difficult
for the Company to raise funds through future offerings of common stock.
A large volume of sales by these selling stockholders could have a significant
adverse impact on the market price of the Company's common stock.
ITEM 2. PROPERTIES
The corporate headquarters is located at 587 Connecticut Avenue, Norwalk, CT
06854-1711. The Company leases this office space from Microphase Corporation
under a facilities agreement with Microphase that provides that mPhase lease
office space, lab facilities and administrative staff on a month-to-month basis
for $11,340/month. The Company also maintains an office at the Georgia Advanced
Telecommunications Technology Center in Atlanta, Georgia.
ITEM 3. LEGAL PROCEEDINGS
The Company has recently been advised that, following an investigation by the
staff of the Securities and Exchange Commission, the staff intends to recommend
that the Commission file a civil injunctive action against Packetport.com, Inc.
(hereinafter "Packetport") and its Officers and Directors. Such recommendation
relates to alleged civil violations by Packetport and such Officers and
Directors of various sections of the Federal Securities Laws. The staff has
alleged civil violations of Sections 5 and 17(a)of the Securities Act of 1933
and Sections 10(b)and 13(d)of the Securities Exchanges Act of 1934. As noted in
other public filings of mPhase, the CEO and COO of mPhase also serve as
Directors and Officers of Packetport. Such persons have advised mPhase that they
deny any violation of law on their part and intend to vigorously contest such
recommendation.
From time to time we may be involved in various legal proceedings and other
matters arising in the normal course of business.
23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
As described in mPhase's Definitive Proxy Statement (DEF-14A), filed on April 8,
2002, the following proposals were submitted to shareholders for their approval
at an annual meeting held on May 15, 2002: (1) a proposal to elect seven (7)
Directors to hold office until the next Annual Meeting; and (2) a proposal to
ratify the appointment of Arthur Andersen LLP or such other qualified auditors
as the Board of Directors may determine is necessary, as the external auditors
for mPhase's fiscal 2002 year. The aforementioned proposals are explained in
greater detail in the Proxy Document; shareholders of record as of April 1, 2002
were entitled to vote before the deadline of May 15, 2002, and the proposals
were approved by the shareholders on that date, with the minor exception that
the auditors appointed by the Board and the shareholders at the meeting was in
fact, Rosenberg Rich Baker Berman & Company ("other qualified auditors").
The vote was as follows: (1) Election of Directors - 32,280,669 votes were cast
in favor of the election of each of the seven directors; and (2) Ratify
Independent Auditors - 31,785,416 votes were cast in favor of ratifying
Rosenberg Rich Baker Berman & Company as the Independent Auditors. Each of the
directors was elected by the same number of votes in favor and there were no
votes against their election.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(A) MARKET PRICES OF COMMON STOCK
The primary market for mPhase's common stock is the NASDAQ OTC Bulletin Board,
where it trades under the symbol "XDSL." The Company became publicly traded
through a merger with Lightpaths TP Technologies, formerly known as Tecma
Laboratories, Inc. pursuant to an agreement dated February 17, 1997. The
following table sets forth the high and low closing prices for the shares for
the periods indicated as provided by the NASDAQ's OTCBB System. The quotations
shown reflect inter-dealer prices, without retail mark-up, markdown, or
commission and may not represent actual transactions. These figures have been
adjusted to reflect a 1 for 10 reverse stock split on March 1, 1997.
YEAR/QUARTER HIGH LOW
---- ---
Fiscal year ended June 30, 2000
First Quarter $ 9.25 $2.97
Second Quarter 6.19 2.50
Third Quarter 19.13 6.50
Fourth Quarter 14.13 6.00
Fiscal year ended June 30, 2001
First Quarter $ 9.25 $3.00
Second Quarter 5.94 1.47
Third Quarter 3.38 1.22
Fourth Quarter 2.61 1.03
Fiscal year ended June 30, 2002
First Quarter $ 1.67 $ .31
Second Quarter .86 .31
Third Quarter .62 .27
Fourth Quarter .50 .23
24
(B) HOLDERS
As of June 30, 2002, mPhase had 60,807,508 shares of common stock outstanding
and approximately 15,000 stockholders of record.
(C) DIVIDENDS
mPhase has never declared or paid any cash dividends on its common stock and
does not anticipate paying any cash dividends in the foreseeable future. The
Company currently intends to retain future earnings, if any, to finance
operations and the expansion of its business. Any future determination to pay
cash dividends will be at the discretion of the Board of Directors and will be
based upon mPhase's financial condition, operating results, capital
requirements, plans for expansion, restrictions imposed by any financing
arrangements and any other factors that the Board of Directors deems relevant.
Issuance of Unregistered Securities
The information required by this item is set forth in note 10 on F-21 attached
hereto and in 10-Q's dated September 30, 2001, December 31, 2001, and March 31,
2002.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical financial statements and notes included in this
annual report. The statement of operations data from October 2, 1996 (date of
inception) to June 30, 1997 and for the year ended June 30, 1998, and the
balance sheet data as of June 30, 1997 and 1998, are derived from financial
statements that have been audited by Schuhalter, Coughlin & Suozzo, LLC,
independent auditors, and are included in this document. The statement of
operations data for the years ended June 30, 1999, 2000, and 2001 and the
balance sheet data as of June 30, 1999, 2000, and 2001 are derived from
financial statements that have been audited by Arthur Andersen LLP., independent
auditors. The statement of operations data for the year ended June 30, 2002 and
the balance sheet data as of June 30, 2002 have been audited by Rosenberg Rich
Baker & Berman, independent auditors, and are included in this document.
25
From Inception Year Ended June 30,
(October 2, 1996) --------------------------------------------------------------
to June 30 1997 1998 1999 2000 2001 2002
------------ ------------ ------------ ------------ ------------ ------------
(in thousands, except share data)
STATEMENT OF OPERATIONS DATA:
Total revenues $ -- $ -- $ -- $ 279 $ 10,524 $ 2,582
------------ ------------ ------------ ------------ ------------ ------------
Costs and Expenses:
Cost of sales -- -- -- 132 5,805 2,415
Research and development 192 2,297 3,563 10,157 10,780 3,820
Licensing Fees 37 450 -- -- -- --
General and administrative 541 1,710 4,683 17,516 16,151 6,490
Depreciation and amortization 11 29 410 471 660 670
Non-cash compensation charge -- -- 13,003 10,343 1,171 548
------------ ------------ ------------ ------------ ------------
Operating loss (781) (4,036) (21,659) (38,340) (24,043) (11,361)
Other income (expense), net -- (305) (1,162) 20 -- 31
Interest income (expense) -- -- (18) 158 43 (26)
------------ ------------ ------------ ------------ ------------ ------------
Net loss $ (781) $ (4,341) $ (22,839) $ (38,162) $ (24,000) $ (11,356)
============ ============ ============ ============= ============ ============
Basic and diluted net
loss per share $ (.10) $ (.46) $ (1.42) $ (1.41) $ (.72) $ (.23)
============ ============ ============ ============= ============ ============
Shares used in basic and diluted
net loss per share 7,806,487 9,336,340 16,038,009 26,974,997 33,436,641 49,617,280
============ ============ ============ ============= ============ ============
Year ended June 30
------------------------------------------------------------
1997 1998 1999 2000 2001 2002
------- ------- ------- ------- ------- -------
BALANCE SHEET DATA: (in thousands)
Cash and cash equivalents $ 162 $ -- $ 7,978 $ 6,432 $ 31 $ 47
Working capital (deficit) (212) (3,073) 4,936 3,557 (1,458) (94)
Total assets 369 2,175 10,624 11,184 8,997 6,942
Long-term obligations, net of
current portion -- -- -- -- 90 1,625
Total stockholders' equity
(deficit) $ (23) $ (915) $ 6,974 $ 7,329 $ 1,865 $ 728
26
The statement of operations data as of the periods indicated below are derived
from unaudited financial statements and include all adjustments (consisting of
normal recurring items) that management considers necessary for a fair
presentation of the financial statements.
Three months ended
------------------------------------------------------------
September 30 December 31 March 31 June 30
------------ ------------ ------------ ------------
(in thousands, except share amounts)
(unaudited)
FISCAL 2002 QUARTERLY
STATEMENT OF OPERATIONS DATA:
Total revenues $ 537 $ 545 $ 866 $ 634
------------ ------------ ------------ ------------
Costs and Expenses:
Cost of sales 457 530 724 704
Research and development 1,111 1,257 539 912
General and administrative 2,644 1,471 1,262 1,114
Depreciation and amortization 193 209 136 132
Non-cash compensation charge 217 170 93 68
------------ ------------ ------------ ------------
Operating loss (4,085) (3,092) (1,888) (2,296)
Interest expense (10) (1) (5) (10)
------------ ------------ ------------ ------------
Loss before other income (expense) 4,095 3,093 1,893 2,306
Other income (expense), net 32 5 86 19
------------ ------------ ------------ ------------
Net loss $ (4,063) $ (3,088) $ (1,807) $ (2,287)
============ ============ ============ ============
Basic and diluted net loss per share $ (.10) $ (.07) $ (.03) $ (.04)
============ ============ ============ ============
Shares used in basic and diluted net
loss per share 42,037,506 44,645,458 55,606,168 56,459,167
============ ============ ============ ============
27
Three months ended
September 30 December 31 March 31 June 30
------------ ------------ ------------ ------------
(in thousands, except share amounts)
(unaudited)
FISCAL 2001 QUARTERLY
STATEMENT OF OPERATIONS DATA:
Total revenues $ 1,865 $ 5,231 $ 2,959 $ 469
------------ ------------ ------------ ------------
Costs and Expenses:
Cost of sales 872 2,779 1,689 465
Research and development 3,162 3,318 2,220 2,080
General and administrative 3,125 2,968 2,873 7,185
Depreciation and amortization 123 136 200 201
Non-cash compensation charge 362 356 232 221
------------ ------------ ------------ ------------
Operating loss (5,779) (4,326) (4,255) (9,683)
Interest income 28 8 4 3
------------ ------------ ------------ ------------
Net loss $ (5,751) $ (4,318) $ (4,251) $ (9,680)
============ ============ ============ ============
Basic and diluted net loss per share $ (.18) $ (.13) $ (.12) $ (.27)
============ ============ ============ ============
Shares used in basic and diluted net
loss per share 31,562,727 32,324,964 34,205,000 35,702,797
============ ============ ============ ============
28
Three months ended
------------------------------------------------------------
September 30 December 31 March 31 June 30
------------ ------------ ------------ ------------
(in thousands, except share amounts)
(unaudited)
FISCAL 2000 QUARTERLY
STATEMENT OF OPERATIONS DATA:
Total revenues $ -- $ -- $ 40 $ 240
------------ ------------ ------------ ------------
Costs and Expenses:
Cost of sales -- -- 19 113
Research and development 1,491 1,904 2,858 3,904
General and administrative 1,164 1,184 7,542 7,626
Depreciation and amortization 114 116 118 123
Non-cash compensation charge 46 42 5,234 5,022
------------ ------------ ------------ ------------
Operating loss (2,815) (3,246) (15,731) (16,548)
Other income, net -- -- -- 20
Interest income 18 41 57 42
------------ ------------ ------------ ------------
Net loss $ (2,797) $ (3,205) $ (15,674) $ (16,486)
============ ============ ============ ============
Basic and diluted net loss per share $ (.11) $ (.12) $ (.56) $ (.55)
============ ============ ============ ============
Shares used in basic and diluted net
loss per share 24,942,965 25,907,602 27,743,996 29,729,060
============ ============ ============ ============
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS AND PLAN OF OPERATIONS
The following is management's discussion and analysis of certain significant
factors, which have affected mPhase's financial position and should be read in
conjunction with the accompanying financial statements, financial data and the
related notes.
RESULTS OF OPERATIONS
OVERVIEW
mPhase is a development-stage company that has designed, patented and is
currently engaged in commercialization of the Company's primary product, the
Traverser(TM). The Company believes that the Traverser(TM) provides a unique
"turnkey" broadband equipment solution that enables telephone companies to
deliver real-time digital television programming, high-speed Internet and voice
service over existing copper telephone lines. The Company believes that the
Traverser(TM) will, in many instances, provide the most cost effective, reliable
and scaleable solution for many telephone companies to provide a comprehensive
suite of bundled or unbundled services, utilizing Asymmetric Digital Subscriber
Line, or ADSL technology. mPhase also manufactures and sells conventional and
intelligent POTS Splitter Shelves and other DSL component products, which are
currently being deployed by telephone companies both in the United States and
abroad.
mPhase was organized on October 2, 1996. On February 17, 1997, the Company
acquired Tecma Laboratories, Inc., a public corporation in a reverse merger
transaction. This resulted in the Company's stock becoming publicly traded on
the NASDAQ Over-the-Counter Bulletin Board. On June 25, 1998, the Company
acquired Microphase Telecommunications, Inc. in a stock for stock exchange,
whose principal assets included patents and patent applications utilized in the
Company's Traverser(TM) product. On August 21, 1998, mPhaseTV.net, Inc. was
organized as a wholly-owned subsidiary to market interactive television and
e-commerce revenue opportunities. This subsidiary is dissolved. On March 2,
2000, mPhase acquired an interest in mPhaseTelevision.Net, Inc., a joint venture
organized to provide digital television programming content to service providers
deploying TV over DSL.
From mPhase's inception, the operating activities related primarily to research
and development, establishing third-party manufacturing and distribution
relationships and developing product brand recognition among telecommunications
service providers. These activities included establishing trials and field tests
of the Traverser(TM) product with Hart Telephone Company in Georgia and
establishing a core administrative and sales organization.
Revenues. To date, all material revenues have been generated from sales of POTS
Splitter Shelves and other DSL component products to a small number of
telecommunications companies. mPhase believes that future revenues are difficult
to predict because of the length and variability of the commercial roll-out of
the Traverser(TM) to various telecommunications service providers. Since the
Company believes that there may be a significant international market for the
Traverser(TM), involving many different countries with different regulations,
certifications and commercial practices than the United States, future revenues
are highly subject to changing variables and uncertainties. Additionally, the
recent instability of the telecommunications market evidenced by reduction in
capital spending across the whole telecom sector contributes to our difficulty
in accurately predicting future revenues.
30
Cost of revenues. The costs necessary to generate revenues from the sale of POTS
Splitter Shelves and other DSL component products include direct material, labor
and manufacturing. mPhase paid these costs to Janifast, Ltd., which has
facilities in the People's Republic of China and is owned by and managed by
certain senior executives of the Company. The cost of revenues also includes
certain royalties paid to Microphase Corporation, a privately held corporation
organized in 1955, which shares certain common management with the Company.
Costs for future production of the Traverser(TM) product will consist primarily
of payments to manufacturers to acquire the necessary components and assemble
the products and future patent royalties payable to GTRC.
Research and development. Research and development expenses consist principally
of payments made to GTRC and Microphase Corporation for development of the
Traverser(TM) product. All research and development costs are expensed as
incurred.
General and administrative. Selling, general and administrative expenses consist
primarily of salaries and related expenses for personnel engaged in direct
marketing of the Traverser(TM), the POTS Splitter Shelves and other DSL
component products, as well as support functions including executive, legal and
accounting personnel. Certain administrative activities are outsourced on a
monthly fee basis to Microphase Corporation. Finally, mPhase leases the
principal office from Microphase Corporation.
Litigation. mPhase has not incurred any material expenses due to litigation
since its inception.
Non-cash compensation charge. mPhase incurred non-cash compensation charges of
$1,170,903 and $548,550, for the fiscal years ended 2001 and 2002, respectively.
The Company makes extensive use of stock options and warrants as a form of
compensation to employees, directors and outside consultants.
TWELVE MONTHS ENDED JUNE 30, 2002 VS. JUNE 30, 2001
Revenues. Total revenues for the year ended June 30, 2002 decreased to
$2,582,446 from $10,524,134 for the year ended June 30, 2001. The decrease was
primarily attributable to slowing sales of the Company's POTS Splitter product
line, caused by the general downturn in the telecommunications market, including
among customers that order component products from the Company. The Company
continues to believe that its line of POTS Splitter products is positioned to be
competitively priced with high reliability and connectivity, and as such has the
potential to be significant part of DSL deployment worldwide. The Company cannot
predict when the demand for telecommunication equipment will resume, however we
do not expect significant sales in the first two quarters of fiscal 2003.
Cost of revenues. Cost of sales was $2,415,129 for the year ended June 30, 2002
as compared to $5,804,673 in the year ended June 30, 2001. Operating margins for
the period ended June 30, 2002 were 6%. The margins have varied dramatically as
spending among telecommunication providers has contracted, coupled with
downward pressures related to the supply and demand of telecommunications
products. Additionally, the Company has offered discounts to certain customers
in the period ended June 30, 2002 causing the margin to decrease.
31
Research and Development. Research and development expenses were $3,819,583 for
the year ended June 30, 2002 as compared to $10,779,570 in the year ended June
30, 2001. Such expenditures include $450,000 incurred with GTRC for the year
ended June 30, 2002 as compared to $3,814,000 during the comparable period in
2001. In addition we incurred $1,212,594 with Microphase and additional
expenses with other strategic vendors for the year ended June 30, 2002 as
compared to $3,405,975 during the comparable period in 2001.
The decrease in research expenditures incurred with GTRC is due to the Company's
nearing completion of the design and manufacture of proptypes of the set top box
and the central office equipment associated with its Traverser(TM) product in
2002.
Research expenditures incurred with Microphase were related to the continuing
development of the Company's DSL component products, including the Company's
line of POTS Splitters and Microfilters and the Company's newest products, the
iPOTS(TM) and mPhase Stretch. We believe the mPhase iPOTS(TM) offers a much
needed solution for the DSL industry; the iPOTS(TM) enables telcos to remotely
and cost-effectively perform loop management and maintenance including line
testing, qualification and troubleshooting. Prior to the introduction of the
iPOTS(TM), loop management could not be remotely performed through a
conventional POTS Splitter without the use of expensive cross connects or relay
banks because of the mandatory DC blocking capacitors in traditional POTS
splitters, as required by the ITU, ANSI and ETSI. The unique (patent pending)
iPOTS(TM) circuit allows most test heads to perform both narrow and wideband
testing of the local loop through the central office POTS Splitter without
having to physically disconnect the POTS Splitter, thereby eliminating the need
to dispatch personnel and a truckroll. The Company anticipates significant
demand for this product, as it significantly reduces the cost of deploying and
maintaining DSL services. Also recently developed is the DSL loop extender
product called mPhaseStretch. This product extends the service distance for the
mPhase Traverser(TM) and can be used in conjunction with other DSL services. The
Company anticipates significant demand for the Stretch loop extender product as
it addresses a primary issue in DSL services.
General and Administrative Expenses. Selling, general and administrative
expenses were $6,490,373 for the year ended June 30, 2002 down from $16,150,711
for the comparable period in 2001. The decrease in the selling, general and
administrative costs included a decrease of non-cash charges relating to the
issuance of common stock and options to consultants, which totaled $2,445,561
for the year ended June 30, 2002 as compared to $6,227,552 during the comparable
period in 2001. The decrease also occurred as a result of the reduction in
workforce in Fiscal 2002 and the reduction in marketing expenses in Fiscal 2002
in response to the current contraction in the telecommunications equipment
market.
Net loss. mPhase recorded a net loss of $11,245,361 for the year ended June 30,
2002 as compared to a loss of $23,998,734 for the same period ended June 30,
2001. This represents a loss per common share of $(.23) in 2002 as compared to
$(.72) in 2001, based upon weighted average common shares outstanding of
49,617,280 and 33,436,641 during the periods ending June 30, 2002 and June 30,
2001, respectively.
32
TWELVE MONTHS ENDED JUNE 30, 2001 VS. JUNE 30, 2000
Revenues. Total revenues for the year ended June 30, 2001 increased to
$10,524,134 from $279,476 for the year ended June 30, 2000. The increase was
primarily attributable to sales of POTS Splitter Shelves and other DSL component
products.
Cost of revenues. Total cost of revenues increased to $5,804,673 for the year
ended June 30, 2001 from $131,756 for the year ended June 30, 2000 due to the
commencement of sales of POTS Splitter Shelves and other DSL component products.
Operating margins for the period ended June 30, 2001 were 45% based on the
limited number of sales achieved. During the year ended June 30, 2001 there was
a general shortage of POTS Splitter Shelves and other DSL component products as
telecommunication companies worldwide began aggressively deploying DSL
technology. Such margins may be materially smaller in the future as a result of
a greater market balance of supply and demand for such products.
Research and development. Research and development expenses increased from
$10,156,936 in the year ended June 30, 2000 to $10,779,570 for the year ending
June 30, 2001. Such amount includes $4,564,000 incurred with GTRC for such
twelve-month period ended in 2000 as compared to $3,814,000 during the
comparable period in 2001. Research and development expenses incurred primarily
with respect to Microphase Corporation and Flextronics increased from $3,328,443
to $3,405,975 for the twelve-month period ended June 30, 2000 as compared to the
twelve-month period ended June 30, 2001.
Research expenditures incurred with Flextronics were due to our increased
efforts in the deployment of the Traverser(TM), including the design and
manufacture of prototypes of the set-top box. Increased research and development
expenditures incurred with Microphase Corporation and Janifast Corporation were
primarily related to development work associated with the POTS Splitter, and
other DSL components.
General and administrative expenses. General and administrative expenses were
$16,150,711 for the twelve-month period ended on June 30, 2001 as compared to
$17,516,216 for the same period ended June 30, 2000. The decrease in
administrative costs included the decrease of non-cash charges for the issuance
of options to consultants which totaled $6,227,552 for the year ended June 30,
2001 as compared to $9,078,311 during the comparable period in 2000, offset by
an increase in salaries and marketing expenses.
Net loss. mPhase recorded a net loss of $23,998,734 for the year ended June 30,
2001 as compared to a loss of $38,161,542 for the same period ended June 30,
2000. This represents a loss per common share of $(.72) in 2001 as compared to
$(1.41) in 2000, based upon weighted average common shares outstanding of
$41,344,367 and 31,404,540 during the periods ending June 30, 2001 and June 30,
2000, respectively.
33
PLAN OF OPERATIONS
RESEARCH AND DEVELOPMENT ACTIVITIES
GTARC has conducted a significant amount of research and development for mPhase
pursuant to a research agreement comprised of a series of delivery orders, which
outline the timing, necessary actions and form of payment for specific tasks
related to the completion of certain components of the Traverser(TM).
For the years ended June 30, 2001 and 2002 and for the period since inception
(October 2, 1996) to June 30, 2002, approximately $3,814,000, $450,000 and
$13,424,300 respectively, has been billed to mPhase for research and development
conducted by GTARC. Subsequent to June 30, 2002, the Company and GTRC and GTARC
entered into a Memorandum of Intention to convert all amounts outstanding and
exchange mutual releases in consideration for two term Notes totaling $624,235
with varied payments through 2007 and warrants to purchase shares of the
Company's common stock through 2007, at a price and formula to be agreed upon.
mPhase is the sole, worldwide licensee of the technology developed by GTARC in
conjunction with the Traverser(TM) product line. Upon completion of the
commercial product, GTRC may receive a royalty of up to 5% of product sales.
The amount of research and development costs the Company has expended from
October 2, 1996, its inception date, through June 30, 2002 was $30,808,774.
During the year ended June 30, 2002, the Company incurred research and
development expenses of $3,819,583 related to the continued development of its
current DSL products and services.
STRATEGIC ALLIANCES IMPLEMENTED
mPhase Technologies, Inc. has signed a worldwide distribution agreement with
Corning Cable Systems, an industry-leading manufacturer of fiber optic and
copper communications network solutions and pioneer of DSL POTS splitter
applications. This agreement enables Corning Cable Systems to resell mPhase's
line of "intelligent" DSL component products including the recently released
Intelligent POTS Splitter (iPOTS(TM)) and UniversalBypass(TM), as well as future
"intelligent" products. This relationship expands mPhase's distribution network
extensively via Corning Cable Systems' worldwide sales force.
Based on this agreement, mPhase will act as the original equipment manufacturer
for Corning Cable Systems, jointly manufacturing the iPOTS product set, as well
as providing sales support and continuing product design and development work.
mPhase is already engaged with Corning Cable Systems in the development of a
next generation iPOTS for a major RBOC.
34
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002 mPhase had working capital of $399,321 as compared to working
capital deficit of $1,458,227 at June 30, 2001. The primary reason for the
improvement in the Company's working capital position at June 30, 2002, were the
conversions of approximately $2.7 million of accounts payable and accrued
expenses due to related parties and strategic vendors to equity, $1.5 million of
accounts payable and accrued expenses due to strategic vendors into Notes
payable and $1.8 million of accounts payable and accrued expenses due to related
parties and strategic vendors expected to be converted to equity in fiscal 2003.
Through June 30, 2002, the Company had incurred development stage losses
totaling approximately $101,366,000. At June 30, 2002, the Company had cash and
cash equivalents of $47,065 compared to $31,005 at June 30, 2001. Historically,
mPhase had funded its operations and capital expenditures primarily through
private placements of common stock. Management expects that its ongoing
financial needs will be provided by financing activities and believes that the
sales of its line of POTS Splitter products and other related DSL component
products will provide some offset to cashflow used in operations, although there
can be no assurance as to the level and growth rate of such sales in future
periods as seen with quarter to quarter fluctuations in component sales. At June
30, 2002, the Company had accounts receivable of approximately $273,780 and
inventory of $3.3 million. This compared to approximately $300,000 of accounts
receivable and $4.3 million of inventory at June 30, 2001.
Cash used in operating activities was $2.7 million during the twelve months
ending June 30, 2002. The cash used by operating activities principally consists
of the net loss, the net decrease in inventory, the net decrease in accounts
receivable offset by the increase in depreciation and amortization, and by
non-cash charges for common stock options and warrants issued for services and
increased accrued expenses. In the year ended June 30, 2002, net cash of
approximately $106,000 was used in investing activities.
The Company has entered into various agreements with GTARC, pursuant to which
the Company receives technical assistance in developing the Digital Video and
Data Delivery System. The Company has incurred expenses in connection with
technical assistance from GTARC totaling approximately $4,563,560, $3,813,683,
and $450,000 for the years ended 2000, 2001 and 2002, respectively, and
$13,424,300 from the period from inception through June 30, 2002. Subsequent to
June 30, 2002, the Company and GTRC and GTARC entered into a Memorandum of
Intent to convert all amounts outstanding and exchange mutual Releases in
consideration for two term Notes totaling $624,235 with varied payments through
2007 and warrants to purchase shares of the Company's common stock through 2007,
at a price and formula to be agreed upon. mPhase is the sole, worldwide licensee
of the technology developed by GTARC in conjunction with the Traverser(TM)
product line. Upon completion of the commercial product, GTRC may receive a
royalty of up to 5% of product sales.
During the quarter ended, December 31, 2001, certain officers, directors and
related parties were issued 2,000,000 restricted shares of the Company's common
stock for the investment of $1,000,000 in cash.
35
During the twelve-month period ended June 30, 2002, the Company raised capital
through private placements with accredited investors, whereby the Company
issued 6,404,174 shares of the Company's common stock and 6,329,174 warrants
each to purchase one share of the Company's common stock at an exercise price of
$.30 per share and 75,000 warrants to purchase one share of the Company's at an
exercise price of $3.00 per share, generating gross proceeds of $1,973,750. The
Company incurred no cash expenses and issued 576,469 shares of its common stock
and 576,469 warrants each to purchase one share of its common stock at $.30 per
share to finders, consultants and investment banking firms in connection with
these private placements.
In addition, certain strategic vendors and related parties converted
approximately $2.7 million of accounts payable and accrued expenses into
7,492,996 shares of the Company's common stock and 5,953,490 warrants. Such
vendors include Microphase Corporation, Janifast, Ltd., and Piper Rudnick LLP,
mPhase's outside counsel.
As of June 30, 2002, mPhase had no material commitments for capital
expenditures.
LOSSES DURING THE DEVELOPMENT STAGE AND MANAGEMENT'S PLANS
Through June 30, 2002, the Company had incurred development stage losses
totaling approximately $101,366,000, and at June 30, 2002 had working capital of
$399,321. The primary reason for the improvement in the Company's working
capital position at June 30, 2002, were the conversions of approximately $2.7
million of accounts payable and accrued expenses due to related parties and
strategic vendors to equity, $1.5 million of accounts payable and accrued
expenses due to strategic vendors into Notes payable and $1.9 million of
accounts payable and accrued expenses due to related parties and strategic
vendors expected to be converted to equity in fiscal 2003. At June 30, 2002, the
Company had approximately $47,065 of cash, cash equivalents and approximately
$273,780 of trade receivables to fund short-term working capital requirements.
The Company's ability to continue as a going concern and its future success is
dependent upon its ability to raise capital in the near term to: (1) satisfy its
current obligations, (2) continue its research and development efforts, and (3)
the successful wide scale development, deployment and marketing of its products.
The Company believes that it will be able to complete the necessary steps in
order to meet its cash flow requirements throughout fiscal 2003 and continue its
development and commercialization efforts. Management's plans in this regard
include, but are not limited to, the following:
We intend to continue to invest in technology and telecommunications hardware
and software in connection with the full commercial production of the
cost-reduced version of the Traverser(TM). Since we have strategically
determined that the cost to a prospective telco to build a master headend is
substantially reduced owing to new developments in technology, we have decided
that mPhaseTV no longer requires access to a satellite uplink facility. Thus the
amount of capital necessary to fund mPhaseTV and mPhase has been substantially
reduced.
We continue our efforts to raise additional funds through private placements of
our common stock and strategic alliances, the proceeds of which are required to
fund continuing development stage expenditures and the commercial roll-out of
our Traverser(TM) Digital Video and Data Delivery System. However, there can be
no assurances that we will generate sufficient revenues to provide positive cash
flows from operations or that sufficient capital will be available when needed
or at terms that we deem to be reasonable.
36
We have evaluated our cash requirements for fiscal year 2003 based upon certain
assumptions, including our ability to raise additional financing and increased
sales of our POTS splitter. The Company anticipates that it will need to raise
additional monies primarily in private placements of its common stock with
accredited investors, and/or a Rights Offering to all of the Company's current
shareholder